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12/14/2008

Why Bankruptcy is the Best Solution for American Auto Companies--Becker

Posner gives an excellent and skeptical discussion of the negotiations over terms of the auto bailout. I am in full agreement with him except on one crucial point: I believe, as I stated in my November 18 discussion, that the big three auto companies should be allowed to go bankrupt. This sharp recession is actually a good rather than bad time for them to go bankrupt.
The global auto industry is in a deep depression, and GM, Ford, and Chrysler have been among the hardest hit. GM said that it expects to produce about 30 percent, or 250,000, fewer cars in the first quarter of 2009 than it did in the comparable quarter of 2008. It is temporarily closing about 20 North American factories in order to make these production cuts. Since they cannot sell their cars anyway because of the depression in car demand, especially for their cars, any disruptive effects bankruptcy would have on their production actually helps them adjust their production of cars to the reduced demand for these cars.
GM and the other carmakers have claimed that bankruptcy would have a particularly big effect on sales because consumers would fear that their warranties on the cars they bought could not be honored in the future. Whether this is true or not would depend on whether consumers expect these companies to emerge from bankruptcy in the future as stronger rather than weaker companies compared to a bailout. If they expect bankruptcy to lead to better labor conditions for the company and smaller debts, bankruptcy would give consumers more rather than less confidence that their warranties would be honored in the future. Furthermore, car prices would only have to fall a little to offset any fears about future warranty protection since car buyers are not willing to pay a lot for warranties.
But suppose for this and possibly other reasons, customers did reduce their demand for cars of the bankrupt American car producers. What would that mean? Presumably, they would not stop buying cars, but they would instead shift their demand toward the closest substitutes; namely, American-made cars of Toyota, Honda, Nissan, and other foreign carmakers. Their share of American made cars is over one third and rising, so bankruptcy of the big 3 might speed up this growth in their share. What that mainly means is increased employment of autoworkers in Tennessee and other states where foreign producers congregate relative to employment of autoworkers in Michigan, Ohio, and other Midwestern states where the factories of the American car producers are mainly located.
I understand the political pressures that the bailout is responding to. The UAW was an important supporter of Obama and Congressional Democrats, whereas the workers in foreign-owned plants are mainly nonunion, and tended to vote more for Republican candidates. Still, one should not confuse the politics of the situation with what is the better economic outcome for consumers, and what is the effect of bankruptcy of the big three automakers on overall American employment and unemployment.
My earlier discussion argued that in fact bankruptcy would strengthen rather than weaken the competitive position of the American automakers, especially when combined with government debtor-in-possessor financing. The bankruptcy proceedings would likely break the union contracts and reduce their pay to levels comparable to those received by American employees of foreign car manufacturers. They would also break the contracts for health payments and pension obligations, which have been significant factors in causing their financial distress. Bankruptcy would also help the companies restructure their debt so that interest payments are much lower. I do not know whether even after all this, the big three can compete effectively in the long-run market for cars--almost surely Chrysler cannot--but bankruptcy combined with management changes, especially at GM, would give them their best chance.
This is certainly true compared to the alternative proposed by the Democrats, which includes the preposterous idea to create an auto "czar" who would oversee the industry. Since when does the American approach to market structure include czars and congressional management of an industry? Such an approach is just an encouragement to the development of a chronically sick patient (American auto producers) who never gets better, and continues to rely on taxpayer support.
It is true that the bankruptcy judge has great powers as well to guide the restructuring of bankrupt companies. However, companies either eventually close down as a result of entering bankruptcy, or emerge as generally more viable companies--as happened with United Airlines and other companies in the airline industry. This is an additional reason why bankruptcy is a much better alternative to a bailout that will cost far more than $25 billion, and could continue for a long time.
I am disappointed that President Bush seems willing to use several billion dollars of the $700 billion financial rescue package to aid the auto companies after Congress could not agree on a bailout. Whatever President-elect Obama will do after taking office, the right policy for the president is to follow Congress' lead and allow American car manufacturers to restructure through bankruptcy.

Comments

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my opinion, from a person acknowledging ABCs of this sort of problems, is also the same as you,sir. the best way for 3 automaker giants is to go bankruptcy. my argument lies in we are never in demand for such cars in today's energy-saving conditions. to switch to manufactor vehicles consuming less fuel seems a must for them. ED Hardy,abercrombie